EXLS

Business Context and Reporting Period

Company: ExlService Holdings, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: ExlService is a provider of outsourcing and transformation services, primarily serving Global 1000 companies in the insurance, utilities, financial services, and transportation sectors. The company operates delivery centers in India and the Philippines, leveraging offshore talent to provide front-, middle-, and back-office process outsourcing (BPO) as well as decision analytics and risk management services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 19.5% to $181.7 million, driven by a $17.9 million increase in outsourcing services and an $11.8 million increase in transformation services. This growth was partially offset by a $6.1 million decrease due to the appreciation of the U.S. dollar against the U.K. pound sterling.
• Profitability Decline: Despite revenue growth, Net Income from continuing operations decreased 36.9% to $11.1 million. This was primarily due to a significant increase in net foreign exchange losses ($9.3 million loss in 2008 vs. $7.6 million gain in 2007) and lower utilization rates at the new Philippines center.
• Discontinued Operations: The company sold its Noida Customer Operations Private Limited (NCOP) subsidiary to Aviva Global Services in August 2008. Income from discontinued operations dropped to $3.3 million in 2008 from $9.5 million in 2007.
• Expense Management: Cost of revenues increased 12.3%, while SG&A expenses increased 12.0%. Gross margin improved to 38.1% from 34.2%.

Guidance, Outlook, Risks, and Contingencies

• Outlook: Management anticipates continued revenue growth through organic expansion and acquisitions. Capital expenditures for 2009 are expected to range between $15 million and $20 million to meet client growth requirements.
• Share Repurchase: The company announced a $10.0 million share repurchase program in November 2008, expiring in November 2009. Approximately $0.3 million had been repurchased by year-end.
• Key Risks:
  • Client Concentration: Two clients (Centrica and Norwich Union) accounted for 34.0% of total revenues in 2008. The loss of either would have a material adverse effect.
  • Foreign Exchange: The company earns revenue primarily in U.S. dollars and U.K. pounds but incurs expenses in Indian rupees. Fluctuations in these rates significantly impact results, as evidenced by the 2008 foreign exchange losses.
  • Tax Holiday Expiration: The company benefits from an Indian corporate income tax holiday expiring in 2010. Expiration will materially increase tax expenses.
  • Employee Turnover: High turnover rates (34.0% for billable employees in 2008) increase recruitment and training costs, impacting margins.
• Contingencies: The company is involved in disputes with Indian tax authorities regarding transfer pricing and permanent establishment status. Assessment orders totaling approximately $8.7 million have been issued for tax years 2003-2006. The company has deposited $5.8 million against these assessments and believes the probability of loss is remote, though further deposits may be required.

Investor Verification Checklist

• Client Concentration: Verify the status of contracts with Centrica (expires Jan 2010) and Norwich Union (framework expires Feb 2012) and the potential impact of non-renewal.
• Foreign Exchange Exposure: Assess the effectiveness of the company's hedging strategy given the significant volatility in INR/USD and GBP/USD rates.
• Tax Liability: Monitor the resolution of Indian tax disputes and the financial impact of the tax holiday expiration in 2010.
• Discontinued Operations: Confirm the finalization of the NCOP sale proceeds and any remaining tax obligations associated with the disposal.
• Capital Expenditures: Track the utilization rates of the new Philippines operations center to ensure it meets projected efficiency targets.